Fed shouldn't try to pop asset bubbles: Mishkin

But central bank should act to limit harm to economy should one burst

NickGodt

NEW YORK (MarketWatch) -- The Federal Reserve shouldn't try to prick an asset bubble, but should be prepared for possible sharp reversals in prices of homes or other assets to ensure they do not do serious harm to the economy, said Fed governor Frederic Mishkin on Wednesday.

"Because subsequent collapses of...asset prices might be highly damaging to the economy, as they were in Japan in the 1990s, should the monetary authority try to prick, or at least slow the growth of, developing bubbles? I view the answer as no," Mishkin said in remarks prepared for delivery to the Forecaster's Club.

But Mishkin added: "I do think that central banks can ensure that sharp movements in the prices of homes or other assets do not have serious negative consequences for the economy."

Mishkin, a professor of banking and finance at Columbia University before he joined the Fed last September, conducted a study of the actions and statements of the Swedish Central Bank, the Sveriges Riksbank, from 1995 until 2005.

He said the Riksbank tried to "lean against the wind" by raising rates last February to retrain home prices.

But Mishkin said this focus on asset prices confused the public about the objectives of the Swedish central bank.

"I heard over and over again in interviews with participants from different sectors of Swedish society that the statements about home prices by the Riksbank confused the public about what it was trying to achieve," Mishkin said.

But Mishkin said he was not saying that a central bank "should stand by idly" while asset prices climb steeply.

He said a central bank can explore different scenarios to assess how it should respond to an asset price collapse.

"This is something we do at the Federal Reserve," he said.

"A central bank can minimize financial instability by being ready to react quickly to an asset price collapse if it occurs," Mishkin said.

Mishkin was talking hypothetically about asset bubbles. While he said there has been an extraordinary run-up in U.S. home prices over the past decade, he added it was "extremely hard to say whether they are above their fundamental value."

In remarks to reporters after his speech, Mishkin said the economy is doing "relatively well and employment is still growing, creating a "benign environment" for the housing market.

The weakness in the housing sector has not been a "big problem" for the rest of the economy.

Mishkin said there are some indications that housing demand is stabilizing.

"In fact, if demand weren't stabilizing, we would have seen a much sharper fall in housing construction," he said.

This housing cycle has been different to others, in that long-term rates have remained low, he added.

"Housing prices take a long time to affect the economy. A decline in housing prices was a big factor in the decline in housing starts, and that feeds into aggregate demand, so that's something we have to be focused on in terms of monetary policy," he said.

Investors have been worried in recent weeks that a pickup in the economy will postpone any interest rate cut from the Federal Reserve to stave off the housing-led economic slowdown.

In a separate speech, Janet Yellen, the president of the San Francisco Fed, said concerns about the possibility of a devastating collapse in the housing market - enough to cause a recession - "have largely been allayed." See full story.

The Fed also released its beige book survey on current economic conditions, which found the housing sector continued to weaken in December. See full story.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.